Now having a good commercial mortgage broker agreement in place with your borrower is more important than ever. As CMBS lenders like Lehman, Silver hill, etc have been taking the worst of it, we as commercial mortgage brokers are now forced to originate our commercial mortgages through traditional sources, i.e. regional or smaller banks.

These banks that for years saw their market share shrink are now in control. Many of them never bothered to increase their risk thresholds and or change their underwriting guidelines to stay competitive. They are now reaping the rewards of that prudence. Bottom line, they still have money to lend and many times their rates are considerable better than the rest of the market.

The challenge however for commercial brokers is that most of these smaller banks are not broker friendly. Or more accurately stated most of them are not set up to work with brokers like the CMBS lenders. For example it’s very rare that a smaller bank will pay rebate or ysp. Once in a while you may find a bank that will pay a .5% or 1% referral fee, but that’s it and it’s rare to find.

Rather many of these banks expect you to get paid on top of their 1% bank fee. Or worse many of them will want you to make your fee outside of close… When was the last time you chased a borrower for a $15,000 commission? If you don’t have it set up right from the beginning you will have a difficult time ever collecting. And besides collecting you will have a hell of a time competing on the deal.

So the point here, besides that this current market reality is not a lot of fun, is that if you think you’ll have to take your deals to a local banks, you’d better have your commercial mortgage broker fee agreement signed and in place before you bother to work on the deal.

To add a little oomph to business these days, LO’s are turning away from the residential realm and focusing their efforts on potentially bigger fish – the commercial arena. Find out the differences between the two markets – from documentation to financing – and why you should line up to tap these unchartered waters. As a bonus, a commercial originator in action shares his words of warning before stepping into bigger territory.

With the subprime fallout, amped up regulation and a slowing residential market, many originators are feeling the squeeze of increased competition and fewer deals.

“Many brokers are making the transition into small commercial lending as a way to serve their existing clients better, and to branch out into a growing market,” said Reed Larsen, vice president of Homeland Mortgage Inc. and Homeland Funding Corp. “Many mortgage brokers have worked hard to build good relationships with their clients over the years, particularly with small business owners and self-employed borrowers who need the kind of expertise and the level of service that good brokers provide. These entrepreneurial clients often ask their brokers about commercial loans, and brokers would rather close those loans than send their hard-earned clients down the road to a competitor.”

What’s the difference?

While both residential and commercial brokers seek to find loan deals for individuals buying property, the methods to get these loans are very different.

Forms

According to Kristin Williams, of Silver Hill Financial LLC, residential deals all require the same forms.
“It’s very standardized,” she said. “1003, 1008, VOD, VOE, etc. But in commercial, each company has their own separate set of documents they require.” In commercial, the deals are all non-standardized and individualized.

Finding value

When it comes to finding comparable in the residential realm, Williams said it is usually easy and quick.

“Traditionally, residential properties are very cookie cutter so you can get several appraisals done very quickly — because there are so many comparable properties out there,” she said. “In commercial, buildings are extremely unique. Appraisal time takes much longer because it’s harder to find similar property types.”

This can lead to more complex, more thorough appraisals — up to 100 pages long — which can take up to four weeks and cost between $1,500 and $4,000.

However, in commercial, “traditionally, LTVs are very limited just because of the riskiness of the transaction,” she said. “They offer lower LTVs to lower their risk. About 75 percent, sometimes 80 percent is the highest LTV for commercial.”

Also, residential originators consider a borrower’s debt-to-income (DTI) ratio by assessing the individual’s personal income. In a commercial transaction, however, a debt service coverage ratio (DSCR) is assessed, which considers how much a property or business occupying the space must have to cover its debt.

In Silver Hill’s case, the following are considered ineligible properties and it would not provide funding: traditional churches, raw land and farms, construction, development, rehab and adult entertainment facilities.

It is best to ask your lender before continuing with the transaction.

How does financing work?

While traditionally, residential brokers can obtain funding with a local lender, LOs need to do a little investigative work to find the best deals for their client. What financing sources are available to commercial brokers?

Banks

“Traditional banks and credit unions are great at offering loans at very competitive rates for your higher-credit-score client,” Williams said. “However, they do have some specific guidelines of the types of properties and the loam amounts. Lots of times, the riskier the property type, the less opportunity you have at a traditional bank.”

Banks also charge a large good faith fee before the loan is even processed, sometimes upwards of $5,000.

SBA loans

SBA loans are multi-faceted if someone wants to pay for the building, business or equipment all in one. It is also good as a standard business loan to provide funding for disaster relief. However, SBA loans take a lot of time — up to 3 months — to finish and requires a lot of documentation.

Private/hard money lenders

Private/hard money lenders are the last-stop shop that is great for high-credit-risk clients, Williams said. They are also bankruptcy or foreclosure friendly.

“They get the loan done quickly,” Williams said. “However, the loan terms are the least favorable with extremely high interest rates — upwards of 15 percent — and the loan balance will come due at a very short period of time.”

There is also a lock-out period that freezes the client from refinancing.

Williams did say, however, that all small-balance commercial lenders have their own set of requirements and procedures and it is important to research them and educate the client before going forward.

Buddying up

Finding a good commercial lender may be easier than originators think, as many are reaching out to brokers — teaching them how to make the residential-to-commercial change and establishing referral relationships.

“As small business in America continues to expand, commercial lenders are reaching out to educate and train mortgage brokers on how to originate commercial loans both as a way to build a viable sales channel into the small commercial market, and as a way to leverage the good relationships brokers have already built with their entrepreneurial clients,” Larsen said. “Lenders are making it easier for brokers to make the transition, by simplifying the application requirements, providing classes, distributing marketing materials and program information, and coaching brokers through the commercial loan process from start to finish.”

Benefits of going commercial

“(Commercial) is the ideal arena for accommodating the skills and experiences of residential mortgage brokers,” said Joe Mardesich, president and CEO of Nationwide Commercial Funding, a national mortgage brokerage. “There are numerous advantages for being in the commercial mortgage business.”

Less sensitive to interest rates

The residential loan business is highly sensitive to interest rates, Mardesich said. The higher the rates, the lower will be the number of homeowners who refinance, take out equity loans or consolidate debt. And though the purchase loan business is still available, it may eventually slow if rates rise to a point where fewer people will be able to qualify as home purchasers.

In the commercial mortgage sector, however, rising rates do not have the considerable negative impact that exists in the residential mortgage sector.

“First, most commercial mortgages have balloon payments,” Mardesich said. “Most commercial borrowers have no choice but to refinance or to sell, regardless of where rates may be, every 5 to 10 years. Both selling and refinancing result in new loans, which of course. mean income for the commercial broker.

“Second, commercial real estate owners and investors make their money by buying, selling, exchanging, developing and refinancing. They don’t stop doing deals as rates move up or down. They find ways to have increased interest costs covered by their tenants or other end-users of their properties. Homeowners, by contrast, want to buy a place in which to live and must factor interest costs into their budgets. If interest rates put homeownership out of their reach, they will remain renters, tenants of those who utilize commercial mortgages.

“Third, as indicated above, rising rates can actually increase rental demand and revenue for the owners of apartments, mobile home parks, and certain other types of properties. The beneficiary is not only the owner, the developer of apartments, and the developer/owner of mobile home parks, but also the mortgage brokers who help to finance those properties.”

Growing competition in the residential mortgage business

According to Mardesich, more and more real estate agents are competing with mortgage brokers.

“The numbers increase daily,” he said. “With the Internet, people can shop online and have 5 or 6 lenders or brokers competing for their business with a mouse click. The loan products you and your competitors sell are all the same, because the secondary market is so consolidated in the residential industry. The residential mortgage business has become a frantic ‘commodity’ business, providing revenue to the lowest bidder.”

In the commercial mortgage business, however, the lowest bidder is not necessarily king. There is much less competition than in residential real estate. And there are many portfolio lenders who do not sell their loans to a consolidated secondary market, i.e. there are a great variety of available programs from one lender or broker to another. As a result, by specializing and developing a niche, you can develop a meaningful competitive edge, Mardesich said.

Less regulation in commercial

The residential industry is chock full of rules and regulations.

However, in the commercial mortgage business, you don’t have to worry about the Real Estate Settlement Procedures Act. There are no Good Faith Estimates. No TILAs. You can pay referral fees to anyone, regardless of the service they may perform. Yield spreads are generally not disclosed. Most states do not require any licensing for commercial mortgage brokers, Mardesich said.

The rewards of commercial

The rewards of the commercial mortgage business can be substantial, impacting income and lifestyle. Yet, comparatively few residential brokers are reaping the rewards that await them in the field of commercial mortgages.

According to Williams, commercial brokers who close with Silver Hill average a commission of $10,400, compared to the $3,000-$8,000 with a residential loan.

“Brokers know that the market is strong and growing,” Larsen said. “They see commercial lending as a great way to serve their existing clients better, provide a more complete array of lending products to new customers, and continue to grow despite the recent woes of the residential lending market. It has never been easier for a good residential loan broker to step up to commercial lending.

Niagara Falls or babbling brook. How is your flow? How do you get commercial mortgage clients in the door? Do you have the budget and time to undertake a massive marketing campaign? Could experience with multiple property types and applications increase your value to the commercial market? Where are your deals located? How is the market in your area? Is your referral network bringing you enough business? These are all questions you need to consider when you think about how to increase your deal flow.

Of course every commercial loan you work will not close; that is not the reality of the commercial mortgage industry. You need to be in front of the right people at the right time with the right solution to even be considered. Here are the 5 main factors that affect your deal flow which ultimately affects your cash flow. The first step is awareness; knowing what the issues are will allow you to determine a solution. Rate yourself in each of these areas:

-Referrals: Referrals are king in the mortgage industry. This is by far the number one way for a commercial broker to get business. This certainly works well for those that have been in the industry for years and have a large network, but what about those new to the industry? Can you survive waiting on someone to refer you when no one knows you exist?

-Marketing: This is how we let our potential clients know who we are and that we can provide them with a solution for their commercial financing needs. The problem is that there are hundreds of other solutions out there all competing for the same client. Without the budget and knowledge to do it right, it is very difficult to get a good return on your marketing investment.

-Expertise: What you know and how long you have been in the business has a dramatic affect on deal flow. Of course, those that have been in the commercial business for 10 years have a greater client base and referral network. You can’t buy experience, no matter how much you spend, but what you can get is training. Through continuing training, especially at the beginning of your commercial career, you can build the knowledge it takes to get the deals done. Share that knowledge with your potential clients and you have set yourself up as the expert in the field, despite your lack of experience.

-Geography: It is no surprise that by serving a larger geographic area, you will be exposed to more deals. However, without the support of a large national company this is very difficult and potentially cost prohibitive. The downside of most national commercial finance companies is that by bringing the deals to you they will expect something in return. Often a big chunk of your commission. It’s a catch 22, you get more clients, but now you need even more than before just to break even.

-The Market: Some markets are hot and some are cold that is the reality of the industry. If you are only serving a small geographic area and that area goes cold, what do you do? The key is to ensure that your client base is as diverse as possible, not only by location, but by property type and industry.
What to do?

Build your commercial finance business. Start by looking at the percentages that each of the above are contributing to your total deal flow and set targets for the coming year as to what you want the percentages to look like. For example, if referrals now make up 10 percent of your total business, set your targets for 20% next year and establish the game plan to do it.

For marketing, are you tracking a cost per closed loan? Do you know what you’re spending for the revenue you’re generating? Begin to cull out the sources that are not generating the returns you require.

When looking at geography, start to examine how you can expand the markets you serve. This will both increase your deal flow and minimize a downward movement in any one particular market. In effect, it is diversifying your portfolio. Look for a partner that can introduce you to new markets and provide you with lead sources into those markets.

In summary, deal flow in the commercial mortgage industry is driven by your presence. When the market knows you’re there and do quality work, your flow will build exponentially. The next step is to formulate your plan to increase that presence and identify the partners that can help you do it.